Question

The interest rate effect, which explains why the AD curve is downward sloping suggest that an increase in the price level??

A) will keep the demand for money constant, keep interest rates constant, and keep consumption and investment spending constant

B) will increase the demand for money, increase interest rates, and decrease consumption and investment spending

C) will decrease the demand for money, reduce interest rates, and increase consumption and investment spending

Answer 1

ans.......
the correct option is B
A decrease in the supply for money will increase interest rates and reduce interest sensitivity consumption and investment spending.
This is because, we know that LM = M/P, a reduction in money supply will shift the LM curve up to the left. An upward shift of LM causes interest rates to rise. An increased interest rates induces the customers to save more in the bank, rather than spending, thereby leading to reduced consumption. An increased interest rates also leads to reduced investment since borrowing becomes more expensive for the investors.